Of Interest

Thursday, October 7, 2010

TOKYO — In a surprise move Tuesday, the Japanese central bank lowered its benchmark interest rate to a range of 0 percent to 0.1 percent, a tiny change from its previous target of 0.1 percent but a symbolic shift back into an age of zero interest rates.
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The Bank of Japan also said it would set up a fund of ¥5 trillion, or $60 billion, to buy Japanese government bonds, commercial paper and other asset-backed securities amid concerns about weakening growth in the economy, the world’s third largest, after those of the United States and China. The bank also kept its credit facility for banks at ¥30 trillion.

With the interest rate cut, a bid to bolster lending in the moribund Japanese economy, the central bank effectively reintroduces a policy of a zero interest rate for the first time since July 2006. The decision underscores concerns that a strong yen and persistent deflation threaten Japan’s economic recovery.

In a statement, the bank confirmed that it would maintain its “virtually zero interest rate policy” until it achieved “medium- to long-term price stability”— or an end to deflation.

Hirokata Kusaba, an economist at the Mizuho Research Institute in Tokyo, said in a note to clients that the bank’s action had gone beyond market expectations. “The latest move gives off a much more powerful impression than past, incremental measures, which had sparked market disillusionment,” he said.

“Though there will be debate over the effects of the monetary loosening, I believe the Bank of Japan has done all it can at this time,” he said. But that also meant that the bank “had now depleted most of its policy options.”

The yen initially fell against the dollar after the announcement, but it later rebounded to ¥83.40 to the dollar, stronger than before the rate change. Ten-year government bond yields rallied on the news, while the Nikkei stock average rose 1.5 percent, its biggest gain in almost three weeks.

“The central outlook for the economy, and prices, have worsened more than had initially been predicted,” said Masaaki Shirakawa, the governor of the Bank of Japan. He called the measures taken Tuesday “comprehensive easing.”

He also said he would consider expanding the ¥5 trillion asset-buying program, depending on its effectiveness.

The unanimous vote to lower the key interest rate came after a two-day meeting of the central bank’s nine-member policy board. The Bank of Japan had been under increasing pressure from the government to take more drastic steps to shore up the economy.

In particular, the government of Prime Minister Naoto Kan has called on the bank to do more to help weaken the powerful yen, which has risen to 15-year highs against the dollar in recent months, wreaking havoc with the country’s export-led economy.

A strong yen hurts Japanese exporters by making their goods more expensive overseas and eroding the value of their overseas revenue. Despite the weaknesses in the Japanese economy, the yen tends to strengthen against other currencies in times of global financial uncertainty, partly because the country still runs a current-account surplus, making a run on the yen unlikely.

The yen’s value is also related to the difference between Japanese interest rates and those elsewhere.

Low rates in Japan give investors more incentive to sell the yen to invest in higher-yielding currencies, weakening the yen. More purchases by the central bank of government bonds and other assets have a similar effect.

Although American officials, at the Federal Reserve and the Treasury Department, declined Tuesday to comment on the Bank of Japan’s interest rate decision, a senior Treasury official suggested that Japan’s efforts to devalue the yen were a source of concern.

It “will be something that we’ll want to discuss this weekend,” when finance ministers from around the world gather in Washington for the annual meetings of the International Monetary Fund and the World Bank, said the official, who spoke to reporters on condition of anonymity under ground rules set by the Treasury.

The official said the United States expected big economies to abide by commitments they made in September 2009 at the Group of 20 leaders’ meeting in Pittsburgh, to support the “rebalancing” of the global economy. In practice, that means that export-oriented surplus economies like China, Japan and Germany should foster domestic demand and encourage imports, while debt-burdened deficit countries, like the United States, should trim their trade and budget deficits.